Rosenberg On The Debt Ceiling

Tyler Durden's picture

When it comes to the debt ceiling, we have heard everyone and the kitchen sink's opinion on this issue at this point. Yet one person who has been silent so far is the original skeptic David Rosenberg. Summarized: "Despite the fear mongering, the U.S. government is not going to default.
Any backup in bond yields from a failure to cobble together a deal will
drive market rates down because of the deflationary implications from
the massive fiscal squeeze that would ensue at a time of a huge 5%
output gap. Even if there were to be some sort of "buyer's strike" if
the U.S. were to be defaulted, rest assured that the Fed would step in
aggressively." Obviously to a mega bond bull like Rosenberg, this is the only possible outcome. After all an alternative would mean the central planners have failed, and the most artificially inflated security in the history of man: US bonds, which are only there because they are the "best of all evils" was enjoying an extended "ignore the emperor's nudity" sabbatical... which alas does not change their evilness, nor is this equilibrium stable once more and more realize it is all about gold at the end of the day. And as yesterday demonstrated when existential fear grips the market, the impossible does happen, and both bonds and stocks can sell off, and in the process lead to all time records for gold. Bookmark July 14: it is a harbinger of what is coming.

U.S. DEBT CEILING ISSUE

Yesterday was one of those rare days where bond yields went up the same day equity prices went down. The two asset classes have been inversely correlated so more days like yesterday are very significant.

I also think you can trace the decline in the major averages yesterday to the time that Geithner spoke when he stressed that August 2nd is the deadline. There is no way out. The rating agencies are saying that the U.S. will face multiple downgrades. I think that a deal will get done at the last minute but it's too late in the game for anything substantial to be attached to a debt ceiling increase. Obama should have offered up what he's suggesting now — big deficit reduction and entitlements on the table — when he unveiled his budget last January. He has no credibility and is playing politics. He proposes large-scale budget gap declines now but with revenue raising measures he knows the hard core GOP will never accept. So he'll blame them. The GOP is playing games of their own because there is no way to redress the fiscal problem with spending cuts alone. Eric Kantor has to be silenced. I think McConnell's idea of giving Obama the authority to raise the debt ceiling unilaterally is the first sign that GOP intransigence is waning. But in the end, it all will come down to the rank and file in the House.

The markets, like most of us, thought this was all posturing and that a deal would be cut by now. Shades of '95. But it's getting late. I think what has investors on edge is the leak that Obama walked out of a meeting with the GOP leadership (aimed at Kantor) and said "enough is enough". Geithner yesterday did not pull a Bob Rubin and say he had another rabbit in the hat. The two sides still appear far apart and more bent on who is going to pay the price in 2012.

Now, the U.S. is hardly going to default in its own currency despite what the rating agencies say or do. I also believe there are constitutional hurdles with not meeting bond repayments. But the message yesterday from the markets — stocks, bonds and the U.S. dollar — is that they are now paying much more attention to this file than they were before. At the margin, investor fear will always lead to raising cash and a cutback in duration.

So there is a risk, even with the weak economy, that bond yields go higher near- term and possibly much higher until this thing is resolved. This then becomes a buying opportunity for longer-duration bonds because Bernanke will act to cap rates, though only after they have risen sharply enough to undercut the stock market. He already hinted loudly that more quantitative easing is on the table and if push comes to shove, he'll monetize the entire deficit.

I can understand that earnings are paramount but frankly I have a hard time believing, Google aside, that on net, profits will perform that well in the current reporting season since I have strong reason to believe that business productivity sagged in Q2. Aside from that, keep an eye on the bond market but remember it was sharp spasms both in 2000 and 2007 that ultimately undermined equity valuation and doomed the economy.

The bottom line is this. Despite the fear mongering, the U.S. government is not going to default. Any backup in bond yields from a failure to cobble together a deal will drive market rates down because of the deflationary implications from the massive fiscal squeeze that would ensue at a time of a huge 5% output gap. Even if there were to be some sort of "buyer's strike" if the U.S. were to be defaulted, rest assured that the Fed would step in aggressively. Perhaps the least-good result for bonds would be a passage of the debt ceiling without at least some down payment in terms of budget austerity. But that is only a matter of timing since putting out the fiscal fires will surely be the dominant campaign theme in the lead-up to the 2012 election.

A far bigger question is what happens next. Will S&P hold true to their word and cut the US on a small deal? And if there is real austerity, even $1 of it, by implication it means no more additional fiscal stimulus period. The economy can not grow without a fiscal or monetary boost. So if D.C. is deadlocked on fiscal stimulus for the next decade, do people really think Bernanke will admit defeat and not print more money to stimulate the "economy" even more?

Source: Gluskin Sheff